From knowing what to buy and when and for how long, equity investing is all about thorough research and analysis. Only one who studies, succeeds

                                      

Some of my friends are diehard equity investors. They are enamoured by multi-baggers. They are inspired by success stories.

They don't like to trade or punt, but buy into themes that appeal to longterm investors. They believe that some day they will have a tiny fortune from successful equity investing. But not all of them make money of the kind they dream of. Why? First, selecting the right stocks is a critical part of the investing process. There are several factors that impact stock prices, and there is still no formula to choose a winning stock that can be repeated without error. A DIY equity investor should have the time and the energy for equity research. Beyond the gut feeling, there is need to develop skills in financial analysis and valuation.

This is best done in a group of like-minded investors, sharing the work based on aptitude and interest. Without discussion, it is easy to miss out critical elements of both qualitative and quantitative analysis. Closet loners need to be very high quality analysts.

Stock selection should get the attention it needs, if a DIY likes to succeed.

Second, developing the right attitude towards valuation is an acquired trait. To estimate if a good stock is worth buying at the price it is trading is difficult. Buying a stock that has moved up from `100 to `300 might be tough, and it would seem like a mistake when the stock hits `600. The fear to buy at `300 will not always convert into the confidence of buying at `600. Many DIY investors will end up being vicarious watchers of winning stocks, since they have not been able to make a decision to buy. It is important to formulate a buying rule that works at one's level of confidence. It is also important to write those rules down. Every investment decision should be documented along with three to four key reasons why that stock was bought. This "investment thesis" helps in evaluating the stock in the future.

Third, equity markets do not comply with the wishes of the investor who bets on them. In most cases, simply waiting will not make things better. Long-term investing is a much-misunderstood idea in equity investing. It applies to a portfolio of stocks, such as a mutual fund, where someone else is monitoring the portfolio. It does not apply to individual stocks that can simply lose value and turn to dust over the long term. Not all deteriorating businesses can turn around. To a DIY investor, quality is everything. If a stock does not behave as expected, if the investment thesis is not playing out, if the management seems to be floundering, there is a good case to move on.

Most DIY investors are too fond of what they own to review the stock dispassionately. This is why writing down the three reasons why the stock was bought, is a good practice. Check if they hold good during review.

Fourth, many DIY investors I know of, take inspiration from Gujarati businessmen and traders. The truth is that equity investing is a treasury operation for many of these businessmen. It is very common for them to put in funds from their business into the equity markets, and pull it out based on a target. Rules for stock investing in Gujarat revolve around such treasury objectives: Book profits quickly; take out the money you have invested and let the balance run freely; do not sit on a loss; buy quickly when you get a tip, else it gets expensive and so on. The trading strategies of the businessman with spare cash is focused on utilising that money profitably. It is like making some money on the side from equity markets. While the rest of the world will use money markets and liquid funds, risk-taking Gujaratis are happy to deploy short-term funds in the stock market. The crux of their approach is agility to move in and out, taking profits and losses with equanimity. This cannot be the strategy for a long-term equity investor who likes to build wealth with equity through careful selection. Trading and investing are two completely different approaches and it is best to not mix the two up.

Fifth, many DIY investors are keen about profit booking. They set targets in their mind. However, they fail completely when it comes to losses. Behavioural scientists have pointed out that our regret about losses is much higher, that we choose to not sell stocks that are in loss, while being gleeful about profit booking. We have to understand our limitation when it comes to projecting how well a business can do and selecting the right ones. As the stocks we hold play out into the future, our eyes should be on correcting errors rather than limiting the potential of our picks. This is why successful investing is about allowing profits to run and cutting losses. Our action should be focussed on throwing out what is not working.

In reality, most DIY investors book out of winning stock too early, while holding on to losers in the hope that they will turn around.

Sixth, how much we invest is much more important than where we invest. Even the best stock that makes us proud with its winning streak will make no difference to our portfolio, if we hold too small a quantity. If we fear that stock markets will crash and take away the fortunes that have been built up, the solution is asset allocation. Booking a profit from one stock and moving into another may not help our case too much when the whole market is going down. It is important to have a big picture view of our equity holdings, and our wealth. How much is in a stock, or a sector, or in equity itself, will impact our wealth much more significantly than short-term reshuffling of money from one to another. Those weightages are what we should manage with care. The richest men in the world are those that took large bets on a few stocks, or just one business that they created and built.

DIY is not a bad idea when it comes to equity. It takes a fine combination of strategy and tactics. Make sure you have yours right, before getting in.